Have you ever wished to have time to research the securities you own or want to buy? In-depth research on a company takes a lot of time, and a lot of information must be screened to do a good job. For busy investors, this is where the analyst comes in. These financial professionals provide investors with basic information about specific securities and provide them with the tools they need to measure the attractiveness of certain investments.
Over the years, the increasing popularity of analyst ratings has expanded their impact on securities prices. The slightest change in an analyst’s rating of a particular stock could take that stock-or throw it into chaos. Some people think that analysts are too powerful; others point to the conflicts of interest facing analysts today. Whatever the reason, it is important that all investors understand the different types of analysts and the factors that drive each analyst to make recommendations.
Buy-side analysts work for large institutional investment companies, such as mutual funds, hedge funds, or insurance companies. They advise on the securities in the employer’s account. These analysts focus their research on specific industries or securities that are of interest to investment companies. These reports are mainly for internal use.
Sell-side analysts are usually employed by broker-dealers and investment banks and are part of the retail investment department. Their recommendations and ratings are created for the sale of investments and are usually provided to clients of brokerage companies for free. The reports issued by sell-side analysts are usually more detailed and focused than those issued by buy-side analysts.
These analysts are not employed by or associated with any specific brokerage company or fund company. Independent analysts aim to provide unbiased and objective ratings. Independent analysts get paid from the companies they research (called fee-based research) or by selling subscription-based reports.
Conflict of interest
Investment Banking Relations
This is one of the most important areas of conflict of interest for analysts. Investment banks are financial institutions that provide services such as underwriting (issuing stocks and bonds); they also act as intermediaries between securities issuers and the investing public. Essentially, when a company decides to go public, it will receive the services of an investment bank to help facilitate the process and sell new securities to investors. Therefore, analysts may face conflicts of interest due to the following reasons:
- If the analyst of a particular security works for the same investment bank that underwrites the new issuance, he/she may be inclined to give positive advice to ensure the issuance is successful. This is no different from the way car dealers operate: all cars have advantages and disadvantages, but most car dealers will tell you that their brand produces the best cars.
- Investment banks are like most other companies. They are always trying to increase profits and can attract more business by publishing favorable reports about their customers. Favorable reports satisfy existing client companies and promote duplication of business. This will give potential companies the impression that if they pay for the services of a particular investment bank, they will benefit from the same favorable report.
Brokers usually generate income from commissions associated with buying and selling transactions conducted by account holders. Although these brokers do not charge any fees for the research reports they provide, they are still profit-oriented organizations. The purpose of their research is to get customers interested in specific stocks, which ultimately leads to more transactions.
Another conflict of interest may arise when the salary of an analyst is related to the performance generated by its rating. Compensation based directly on the number of new investment bank transactions generated by analyst reports or the overall profitability of investment banks will put subtle (perhaps unintentional) pressure on analysts to issue positive reports and recommendations.
Through direct ownership or joint stock purchase programs, analysts and employees of investment banks may own the stocks they recommend. As a result, analysts may be reluctant to issue bad reports or recommendations on the securities they own because this may affect their personal profits.
Although there are many conflicts of interest that may affect analysts’ recommendations, we should note that the US government and the Securities and Exchange Commission (SEC) have enacted regulations to curb the various conflicts faced by analysts.
How to determine the analyst’s objectivity?
In most cases, you will find the analyst’s conflict of interest (if any) in the disclaimer found at the end of any analyst report. The disclaimer discloses the type of relationship between the research company and the analyzed company and how the analyst or research company is paid (whether they should be paid). Please note, however, that just reading the disclaimer does not give you a complete understanding of the relationship between the analyst and the company it reports.
Analysts are not all bad guys
The historical impression of analysts as “whipping boys” in the financial industry is another example of a small number of immoral people destroying the reputation of others. Regardless of the analyst’s suggestions on the stock, the research report still contains company information, such as last year’s performance highlights, ratio analysis, past growth trends, and other relevant information that requires a lot of personal days to compile.
No matter what you think about analysts and their industry, we hope this article will give you a general idea of what analysts do.Next time you read the research report carefully, you will know more about how to judge the completeness of the research and the completeness of the analyst